The prospect of a pounds 50bn public sector borrowing requirement in 1993/4, implying the need to sell pounds 40bn of new gilt-edged stock, has hung over the UK financial markets for weeks because it is equivalent to an entire year's expected cash inflow into UK life assurance, insurance and pension funds. Meanwhile, a large corporate rights issue queue has been forming.
There is no doubt that the money to finance the PSBR will be found. The question has been what will 'give'. Will gilt yields have to rise to absorb the extra bonds or will institutions run down holdings of cash, equities and overseas assets? Is the UK personal sector or foreign investor likely to leap into the breach? Or will the Government simply abandon its 'full-funding' rule on a temporary basis?
David Shaw, the strategy director at Legal & General Investment Management, reckons that the Government really does have a problem. L&G's theoretical model of where to allocate assets says that big investors should be overweight in UK equities and underweight in gilts for the rest of this year and into 1994 as the economic recovery gets under way.
L&G is not alone among fund managers in this view and this must support its forecast of a rise in 15-year gilt yields from 8.5 to 9.25 per cent by next year. If the UK institutional investor is not going to stump up for the Government's new gilts, then what about the foreigner? The bad news is that L&G believes investors worldwide will be switching out of bonds into equities during the second half of this year. The good news is that they could be tempted into gilts if sterling looked sufficiently undervalued.
In addition, once sterling has been hammered into the floor, it may be safer for the Government to contemplate issuing bonds in overseas capital markets to raise funds without running a substantial exchange-rate risk. Sterling's weakness may not be such bad news after all.Reuse content